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The Fed at Tea!

Thu, May 10 2007, 07:49 GMT
by Clifford Bennett

FxMax

A Fed that maintains a tightening bias in the midst of a slowing economy and moderating inflation is a far greater negative and risk to the US dollar, than a Fed that would move to cut rates.

While acknowledging moderate growth expectations the statement remained, as expected by us, basically the same with the emphasis being a watch on inflation. It seems the FOMC mostly sat and had tea and biscuits this week. The Fed maintains a tightening bias, and therefore the prospect of the worse case scenario which I have previously outlined of a stubborn FOMC watching the economy steadily slow or even decline, remains very much on the horizon.

There is a real risk here that the US Federal Reserve Bank is going to drive the US economy into the ground, thereby triggering a sharp, rather than orderly fall in the US dollar, and potentially US equity markets as well. Equity markets exhibit signs of a bubble mentality but while corporate profits are maintained this should not be a problem. If however the US economy continues to stumble with a central bank watching for any signs of an up-tick in inflation, then everything could come to a crunch in the next few months.

Overall the US dollar remains in decline on the basis of the deficits, and more balanced global capital allocation which diminishes the support of those deficits.

It could also be argued in a long term sense that the US has peaked as a geopolitical power about 5 years ago, similarly to the Roman Empire, militarily over-extended with a paralyzed political centre. This does not mean China or anyone else is about to surpass the US, just that the margin between the US and the rest of the world, economically and politically, is now on a steadily diminishing narrowing path.

The US dollar now only ranks in terms of status as a reserve currency, equal to the Euro. It will take several years for the major institutions around the world to achieve in their actual portfolios this historically fresh perception. Throughout this period the flow of capital to the US may well be less than to the Euro.

The outlook for EUR/USD remains decidedly bullish, looking for 1.3900 at any moment now, then 1.4500 by year end. The immediate downside testing is favoured to be well bought by large institutions in the 1.3500 1.3450 area. Technically the worst case immediate scenario is probably a brief dip to 1.3450, but tend to favour the immediate support at 1.3520 will hold. We need a recovery of minor resistance at 1.3580 to further encourage our immediate bullish view.

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Published on  Thu, May 10 2007, 07:53 GMT